economic theory


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“The most effective way of making everybody serve the single system of ends toward which the social plan is directed is to make everybody believe in those ends. To make a totalitarian system function efficiently, it is not enough that everybody should be forced to work for the same ends. It is essential that the people should come to regard them as their own ends.”[p.171]

Berit’s comment: Ponder that statement. It helps explain the significance of universal service-learning. Like socialist youth in Nazi (National Socialism) and Communist countries, all must embrace the new ideology. Those who don’t — the intolerable dissenters — must be silenced. The next section elaborates:

“Although the beliefs must be chosen for the people and imposed upon them, they must become their beliefs, a generally accepted creed which makes the individuals as far as possible act spontaneously in the way the planner wants. If the feeling of oppression in totalitarian countries is in general much less acute than most people in liberal countries imagine, this is because the totalitarian governments succeed to a high degree in making people think as they want them to.”[p.171]

 The strategies that accomplish this mental change include numerous subtle and obvious forms of propaganda. Schools, the media, children- and youth-service teams, corporations, etc…. every source of propaganda must share the same vision. Though totalitarian, it will be designed to sound noble, compassionate and fair to all. Yet the result with be the exact opposite.

Ponder this warning from Dr. Thomas Sowell‘s review of Road to Serfdom:

 

“At the heart of the socialist vision is the notion that a compassionate society can create more humane living conditions for all through government ‘planning’ and control of the economy….

 

“The rule of law, on which freedom itself ultimately depends, is inherently incompatible with socialism. People who are free to do as they wish will not do as the economic planners wish. Differences in values and priories are enough to ensure that. These differences must be ironed out by propaganda or power, if socialism is to be socialism. Indoctrination must be part of the program, not because socialist want to be brainwashers, but because socialism requires brainwashing.

 

Idealist socialist create systems in which idealist are almost certain to lose and be superseded by those whose drive for power, and ruthlessness in achieving it, make them the “fittest” to survive under a system where government power is the ultimate prize.… The issue is not what anyone intends but what consequences are in fact likely to follow.”[39]

 

In his article, aptly titled “A Road to Hell Paved with Good Intentions,” Sowell points out that “Marxism as an ideal continues to flourish on American college campuses, as perhaps nowhere else in the world.” Collectivist visions appeal to academic idealists and others who ignore the lessons of history.

“….all propaganda serves the same goal—that all the instruments of propaganda are coordinated to influence the individuals in the same direction…. The skillful propagandist then has power to mold their minds in any direction he chooses, and even the most intelligent and independent people cannot entirely escape that influence if they are long isolated from all other sources of information. [p.171-172]

President Obama is now taking control of this change process by transferring workers from the private sector (corporations, private enterprise…) to the government service sector. With the controlled media on his side, the masses are not exposed to contrary facts.

“…even the striving for equality by means of a directed economy can result only in an officially enforced inequality—an authoritarian determination of the status of each individual in the new hierarchical order—and that most of the humanitarian elements of our morals, the respect for human life, for the weak, and for the individual generally, will disappear….

“The moral consequences of totalitarian propaganda which we must now consider are, however, of an even more profound kind. They are destructive of all morals because they undermine one of the foundations of all morals: the sense of and the respect for truth.

“…in order to induce people to accept the official values, these must be justified, or shown to be connected with the values already held by the people, which usually will involve assertions about causal connections between means and ends.  …people must be brought to agree not only with the ultimate aims but also with the views about the facts and possibilities on which the particular measures are based.[p.172]

Al Gore’s battle against a mythical man-made global warming crisis illustrates this point. Globalist change agents agree that a worldwide crisis is needed to persuade humanity to embrace all the costly restrictions and regulations of government controlled “sustainable development.” So they are willing to ignore facts and embrace myths and pseudo-science in order to reach their goal.

“We have seen that agreement on that complete ethical code, that all-comprehensive system of values which is implicit in an economic plan, does not exist in a free society but would have to be created….

“And while the planning authority will constantly have to decide issues on merits about which there exist no definite moral rules [apart from the Bible], it will have to justify its decisions to the people—or, at least, have somehow to make the people believe that they are the right decisions….

“This process of creating a ‘myth’ to justify his action need not be conscious. …  So [the totalitarian leader] will readily embrace theories which seem to provide a rational justification for the prejudices which he shares with many of his fellows. Thus a pseudoscientific theory becomes part of the official creed which to a greater or lesser degree directs everybody’s action. [p.173]

“The need for such official doctrines… has been clearly foreseen by the various theoreticians of the totalitarian system…. They are all necessarily based on particular views about facts which are thenelaborated into scientific theories in order to justify a preconceived opinion.

“The most effective way of making people accept the validity of the values they are to serve is to persuade them that they are really the same as those which they… have always held, but which were not properly understood or recognized…. The people are made to transfer their allegiance from the old gods to the new under the pretense that the new gods really are what their sound instinct had always told them but what before they had only dimly seen. And the most efficient technique to this end is to use the old words but change their meaning. Few traits of totalitarian regimes are … so characteristic of the whole intellectual climate as the complete perversion of language….

“The worst sufferer in this respect is, of course, the word ‘liberty.’ It is a word used as freely in totalitarian states as elsewhere…. Dr. Karl Mannheim… warns us that ‘a conception of freedom modeled on the preceding age is an obstacle to any real understanding of the problem. But his use of the word freedom is as misleading it is in the mouth of totalitarian politicians. Like their freedom, the ‘collective freedom‘ he offers us is not the freedom of the members of society but the unlimited freedom of the planner to do with society what he pleases….[pps.174-175]

“In this particular case the perversion of the meaning of the word has, of course, been well prepared …. by many of the theoreticians of socialism. But ‘freedom’ or ‘liberty’ are by no means the only words whose meaning has been changed into their opposites to make them serve as instruments of totalitarian propaganda. We have already seen how the same happens to ‘justice’ and “law,’ ‘right’ and ‘equality.’ The list could be extended until it includes almost all moral and political terms in general use.

“… the confusion becomes worse because this change of meaning of the words describing political ideals is not a single event but a continuous process, a technique employed consciously or unconsciously to direct the people….

“It is not difficult to deprive the great majority of independent thought. But the minority who will retain an inclination to criticize must also be silenced. … Since many parts of this code will never be explicitly stated… every act of the government, must become sacrosanct and exempt from criticism. If the people are to support the common effort without hesitation, they must be convinced that not only the end aimed at but also the means chosen are the right ones.”[p.175]

Facts and theories must thus become no less the object of an official doctrine than views about values. And the whole apparatus for spreading knowledge—the schools and the press, radio and motion picture—will be used exclusively of to spread those views which, whether true or false, will strengthen the belief in the rightness of the decisions taken by the authority; and all information that might cause doubt or hesitation will be withheld.”[p.176]

Stanford University Professor Steven Schneider illustrates it well. He said,

“On the one hand, as scientists, we are ethically bound to the scientific method, in effect promising to tell the truth, the whole truth, and nothing but–which means that we must include all the doubts, the caveats, the ifs, ands, and buts. On the other hand, we are not just scientists but human beings as well. And like most people, we’d like to see the world a better place, which in this context translates into our working to reduce the risk of potentially disastrous climatic change.
“To do that, we need to get some broad based support, to capture the public’s imagination. That, of course, entails getting loads of media coverage. So we have to offer up scary scenarios, make simplified, dramatic statements and make little mention of any doubts we might have… Each of us has to decide what the right balance is between being effective and being honest.” (See endnote #38 in Saving the Earth)

This applies even to fields apparently most remote from any political interests and particularly to all the sciences, even the most abstract. That in the disciplines dealing directly with human affairs and therefore most immediately affecting political views, such as history, law or economics, the disinterested search for truth cannot be allowed…. These disciplines have, indeed, in all totalitarian countries become the most fertile factories of the official myths which the rulers use to guide the minds and wills of their subjects….” [p.176]

n “Government religion in the United States,” Erica Carle wrote:
“The separation of church and state argument for removing all traces of Biblical teaching from public life and public land is a gigantic fraud. Why? Because there is no separation of church and state. Government religion is a fact in the United States. What is wanted by the government religion adherents is not separation of church and state, but exclusive rights for their religion.”What is the government religion? Auguste Comte (1798-1857), its French founder, called it the Religion of Humanity. The doctrines of the Positive Religion are now taught in the schools as a science which Comte called sociology. Sociology was to be the ruler science over all the other sciences and also the science of managing the world…. In a country that is supposed to be free,

  • its citizens are being subjected to sociological management,
  • its scientists and elected officials to sociological control, and
  • its youth to sociological education.

“…we must yet be on our a guard not to dismiss .[these aberrations] as mere accidental by-products which have nothing to do with the essential character of a planned or totalitarian system….They are a direct result of that same desire to see everything directed by a ‘unitary conception of the whole.’…

 

“Once science has to serve, not truth, but the interests of a class, a community or a state…. As the Nazi minister of justice has explained, the question which every new scientific theory must ask itself is: ‘Do I serve National Socialism for the greatest benefit of all?’
The word ‘truth’ itself ceases to have its old meaning.  …it becomes something to be laid down by authority, something which has to be believed in the interest of the unity of the organized effort and which may have to be altered as the exigencies of this organized effort require it.
“The general intellectual climate which this produces, the spirit of complete cynicism as regards truth which it engenders, the loss of the sense of even the meaning of truth, the disappearance of the spirit of independent inquiry…. Perhaps the most alarming fact is that contempt for intellectual liberty is not a thing which arises only once the totalitarian system is established but one which can be found everywhere among intellectuals who have embraced a collectivist faith and who are acclaimed as intellectual leaders even in countries still under a liberal regime.

 

“Not only is even the worst oppression condoned if it is committed in the name of socialism, and the creation of a totalitarian system openly advocated by people who pretend to speak for the scientists of liberal countries; intolerance, too, is openly extolled….” [p.178]

“This view is, of course, practically indistinguishable from the views which led the Nazis to the persecution of men of science, the burning of scientific books, and the systematic eradication of the intelligentsia of the subjected people.

“The desire to force upon the people a creed which is regarded as salutary for them is, of course, not a thing that is new or peculiar to our time. New, however, is the argument by which many of our intellectuals try to justify such attempts.” [p.179]
The tragedy of collectivist thought is that, while it starts out to make reason supreme, it ends by destroying reason….”[p.180]

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The pronunciation in English is lay-say-fair. Its French origins date back to the late Renaissance. As the story goes, it was first used about the year 1680, a time when the nation-state was on the rise throughout Europe. The French finance minister, Jean-Baptiste Colbert, asked a merchant named M. Le Gendre what the state could do to promote industry.

According to legend, the reply came: “Laissez-nous faire,” or “let it be.” This incident was reported in 1751 in the Journal Oeconomique by the free-trade champion Rene de Voyer, Marquis d’Argenson. The slogan was codified finally in the words of Vincent de Gournay: “Laissez-faire et laissez-passer, le monde va de lui même!” The loose translation: “Let it be and let goods pass; the world goes by itself.”

To generalize the principle: Leave the world alone, it manages itself.

A Simple, Beautiful Ideal

People should enjoy the liberty to manage their own lives, associate as they please, exchange with anyone and everyone.

All these renderings express not only the idea of free trade — a main subject of dispute in 18th-century European politics — but also a larger and more-beautiful vision of the way society can be permitted to work.This idea can be summed up in the phrase “laissez-faire,” or in the doctrine of what was once called simply liberalism, which today is clarified as classical liberalism. This idea is this: Society contains within itself the capacity for ordering and managing its own path of development. It follows that people should enjoy the liberty to manage their own lives, associate as they please, exchange with anyone and everyone, own and accumulate property and otherwise be unencumbered by state expansion into their lives.

In the centuries that have followed, millions of great thinkers and writers have elaborated on this core idea within all disciplines of the social science. Then as now, there stand two broad schools of thought: those who believe in state control of one or many aspects of the social order and those who believe that such attempts at control are counterproductive to the cause of prosperity, justice, peace and the building of the civilized life.

These two ways of thinking are different from what is called the Right and the Left today. The Left is inclined to think that if we let the economic sphere be free, the world will collapse, which advances some theory of the disaster that would befall us all without government control. The Right is similarly convinced that state control is necessary lest the world collapse into violent, warring, culture-destroying gangs.

The laissez-faire view rejects both views in favor of what Claude Frédéric Bastiat called “the harmony of interests” that make up the social order. It is the view that the artists, merchants, philanthropists, entrepreneurs and property owners — and not the cartelizing thugs with state power — ought to be permitted to drive the course of history.

This view is now held by millions of thinkers around the world. It is the most exciting intellectual movement today, and in places where we might least expect to find it.

The growth of the idea of laissez-faire in our times is infused with a digital energy. Distributed networks take the idea to a whole new level: no one in control but everyone in control, with no central point of failure.

But the idea itself is not new in world history.

Deep Roots

Though it is mostly associated with 18th-century British thought, it is a view of society that has much-deeper roots in the Christian Middle Ages and early Jewish thought. Nor is laissez-faire somehow a Western idea alone. The deepest roots of laissez-faire actually trace to ancient China, and even today, the thoughts of the masters offer a fine summary.

Here are some examples from non-Western thought:

Lao Tzu (6th century B.C.): “The more artificial taboos and restrictions there are in the world, the more the people are impoverished…The more that laws and regulations are given prominence, the more thieves and robbers there will be…”

“The Sage says: ‘I take no action, yet the people transform themselves, I favor quiescence and the people right themselves, I take no action and the people enrich themselves…’”

Chuang Tzu (369-286 B.C.): “I would rather roam and idle about in a muddy ditch, at my own amusement, than to be put under the restraints that the ruler would impose. I would never take any official service, and thereby I will [be free] to satisfy my own purposes….” The world “does simply not need governing; in fact, it should not be governed.”

Pao Ching-yen (4th century A.D.): “Where knights and hosts could not be assembled, there was no warfare afield…Ideas of using power for advantage had not yet burgeoned. Disaster and disorder did not occur…People munched their food and disported themselves; they were carefree and contented.”

The inviolability of property rights, the primacy of peace in world affairs and the centrality of free association and trade in the conduct of human affairs.

Ssu-ma Ch’ien (145-90 B.C.): “Each man has only to be left to utilize his own abilities and exert his strength to obtain what he wishes…When each person works away at his own occupation and delights in his own business, then like water flowing downward, goods will naturally flow ceaseless day and night without being summoned, and the people will produce commodities without having been asked.”These early beginnings of the idea began here but can be traced through thinkers of ancient Greece and Rome and through the Middle Ages, until the notion swept the world in the 18th and 19th centuries, giving rise to unheard-of prosperity, liberty and peace for all. In the 18th century and in large parts of the world (other than the English-speaking world), laissez-faire has been called liberalism or classical liberalism, a doctrine of social organization that can be summed up in the words of Lord Acton: Liberty is the highest political end of humankind.

20th Century Corruption

To be sure, the notion of liberalism was already corrupted early in the 20th century. As Ludwig von Mises wrote in his book Liberalism (1929), “The world today wants to hear no more of liberalism. Outside England, the term ‘liberalism’ is frankly proscribed. In England, there are, to be sure, still ‘liberals,’ but most of them are so in name only. In fact, they are rather moderate socialists. Everywhere today, political power is in the hands of the anti-liberal parties.”

That remains true today. And the revolt against this is often termed “libertarian,” a word that has long been associated with a primary concern for human liberty. It was a neologism for the postwar generation that was synonymous with liberalism. In current understanding, it refers to a tightening and radicalizing of the old liberal view. It asserts the inviolability of property rights, the primacy of peace in world affairs and the centrality of free association and trade in the conduct of human affairs.

It Can Exist

The state is on the march, but the resistance is growing.

Such a society is not historically unprecedented. Murray Rothbard wrote about Colonial America as an example of a wildly successful experiment of society without centralized state management. Medieval Europe made the first great economic revolution without recourse to the power of the nation-state. David Friedman has documented competitive legal orders in medieval Iceland. Other writers go so far as to say that given how we conduct our lives day to day, relying on the productivity of private institutions and associations, we never really leave a practical anarchy.As Mises says, liberalism/libertarianism/laissez-faire is not a completed doctrine. There are so many areas remaining to be explored and so many applications to make both in history and in our time. The most exciting books of our time are being written from the vantage point of human liberty. The state is on the march, but the resistance is growing.

It is a debilitating thing to watch the state push and push to gain more power, under the flags of Equality or Greatness or Security or Fairness, but it is a source of joy to know that ideas are more powerful than all the armies of the world. Reason, clarity, innovation, and relentless work for what is right and true will eventually lead the idea of laissez-faire to victory.

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The theoretical foundation for the book comes from Ludwig von Mises, the great Austrian economist, who pointed out that credit is a claim on resources. Tamny reasons that if credit is a claim on resources, then new credit cannot be created unless new resources are created. This renders the idea of ‘excess credit’ an oxymoron. And if there cannot be more credit than output than there cannot be an excess of credit over output.

This line of reasoning causes Tamny to call in to doubt the Austrian Theory of the Business Cycle, at least the popularly understood versions of it. After all, if there can’t be excess credit at all, then there certainly can’t be excess-credit-driven over-production. Yes, some parts of the economy can grow too much, due to credit mis-allocation, but the economy in general cannot be made to grow above capacity due to allege ‘excess credit’. Thus, the Fed doesn’t cause economy-wide bubbles, only sectional distortions. Central bank interventions such as interest rate setting, on balance, actually decrease the expansion of the economy – perhaps even during the ‘bubble’ period.

On the way to this conclusion, Tamny takes aim at the idea that under a fractional reserve banking system, new money is created in the banking system according to a ‘money multiplier’. In doing this, he stays faithful to supply-side thinking, but veers greatly from almost every other camp, including the mainstream.

I welcome Tamny, a former editor of mine at Forbes and a good friend, into this debate. If the ideas he’s attacking can withstand the attack, then they’ll be stronger for having been challenged. If not, then good riddance to them. The theoretical foundations of the money multiplier are in need of a shaking up. So is monetarism. The Fed quadrupled monetary base in response to the Great Recession, and many commentators called for imminent spikes of high, perhaps even hyper, inflation.

Since early 2010 I, myself, have been a short-term inflation dove (but long-term inflation hawk) because I had  concluded that financial over-regulation and the European debt crisis would cause money to be hoarded both domestically and abroad, and that inflation would tarry until those issues had resolved themselves.  This put me at odds with many of the most highly visible Austrians and monetarists, many of who have been veritable Chickens Little clucking about imminent hyper-inflation. This has given ammunition to left-of-center critics such as Paul Krugman.

Tamny’s answer as to why exploding led balance sheets have not led to exploding price inflation is that the Fed cannot create money and therefore quadrupling its balance sheet does not cause inflation.

I think the Austrian answer would be that the Fed cannot create money by itself, but that it needs banks and their money multiplier to do so. For Rothbard and his acolytes, this process is akin to counterfeiting and should be illegal because it is a form of fraud. To tolerate fractional reserve banking is to invite exploding inflation. The milder form of this view comes from monetarists who favor higher capital requirements for banks to reign in the money multiplier.

But what about the natural brakes on the multiplier? Banks don’t just lend ad infinitum: There are many nations in the world which do not place any reserve requirements on their banks. What prevents them from infinite money multiplication? Answer: Incentives. If bankers over-lend, they will end up lending to those who are unlikely to repay. Banks end up eating the loss…or at least suffering the humiliation of bail-out and Federal takeover.

One of the key issues goes back to a debate about what this stuff called M2, quasi-money which results from the money multiplier actually is. For supply-siders, these deposits are called credit. For Austrians, they are called money. But although this argument has a semantic aspect, there are more than semantics at issue: there’s a methodological difference.

Austrians tends to focus on theory: definitions of words, deductive processes of reasoning. Tamny comes at this as a financial journalist first and a theoretician second. He sees a world in which the Fed has exploded its balance sheet without seeming to have made much difference. He sees a world in which most business lending is done outside of the world of banks and their fractional reserve powers of multiplication. He sees a world in which credit seems quite difficult to get, even though the Fed has embarked on ‘easy money’ policies. And if reality doesn’t square with the traditional theories, even of allies, then so much the worse for the theories.

When I asked Tamny in a recent interview where debasement does come from (if not from the Fed) he acknowledged that he really doesn’t have a firm answer, and called for the thinkers of the various schools to get together and hash that question out. I think that would be a good idea. What I’ve always loved about supply-side thinking is its willingness to look at the world as it is and learn economics from the economy instead of from economists. On the other hand, what I’ve always loved about Austrian economics is that it sees economics as the science of human action, which potentially makes it highly adaptable. If economics is big enough to include all the ways people try to get what they want, then its theoretical limits are as unconstrained as the variety of human wants and means. This makes Austrian theory expandable enough to include anything which we economists can observe.

Tamny has revived moribund monetary theory debates between supply siders and Austrians of yore by once again taking up the supply side arguments against money multipliers. By doing so he has done all the camps a service by shaking things up enough to create an opportunity for all of us to improve our thinking.

I sat down across a Skype line with Tamny recently to talk about Who Needs the Fed?, what supply-siders can learn from the working class revolt which swept Trump into office, and a few other topics. You can listen to the interview here.

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In the midst of so many economic fallacies being repeatedly seemingly without end, it may be helpful to return to some of the most basic laws of economics. Here are ten of them that bear repeating again and again. 

1. Production precedes consumption

Although it is obvious that in order to consume something it must first exist, the idea to stimulate consumption in order to expand production is all around us. However, consumption goods do not just fall from the sky. They are at the end of a long chain of intertwined production processes called the “structure of production.” Even the production of an apparently simple item such as a pencil, for example, requires an intricate network of production processes that extend far back into time and run across countries and continents.

2. Consumption is the final goal of production

Consumption is the objective of economic activity, and production is its means. The advocates of full employment violate this obvious idea. Employment programs turn production itself into the objective. The valuation of consumption goods by the consumers determines the value of production goods. Current consumption results from the production process that extends to the past, yet the value of this production structure depends on the current state of valuation by the consumers and the expected future state. Therefore, the consumers are the final de facto owners of the production apparatus in a capitalist economy.

3. Production has costs

There is no such thing as a free lunch. Getting something apparently gratis only means that some other person pays for it. Behind every welfare check and each research grant lies the tax money of real people. While the taxpayers see that government confiscates part of one’s personal income, they do not know to whom this money goes; and while the recipients of government expenditures see the government handing the money to them, they do not know from whom the government has taken away this money.

4. Value is subjective

Valuation is subjective and varies with the an individual’s situation. The same physical good has different values to different persons. Utility is subjective, individual, situational and marginal. There is no such thing as collective consumption. Even the temperature in the same room feels differently to different persons. The same football match has a different subjective value for each viewer as can be easily seen the moment when a team scores.

5. Productivity determines the wage rate

The output per hour determines the worker’s wage rate per hour. In a free labor market, businesses will hire additional workers as long as their marginal productivity is higher than the wage rate. Competition among the firms will drive up the wage rate to the point where it matches productivity. The power of labor unions may change the distribution of wages among the different labor groups, but trade unions cannot change the overall wage level, which depends on labor productivity.

6. Expenditure is income and costs

Expenditure is not only income, but also represents costs. Spending counts as costs for the buyer and income for the seller. Income equals costs. The mechanism of the fiscal multiplier implies that costs rise with income. In as much as income multiplies, costs multiply as well. The Keynesian fiscal multiplier model ignores the cost effect. Grave policy errors are the result when government policies count on the income effect of public expenditures but ignore the cost effect.

7. Money is not wealth

The value of money consists in its purchasing power. Money serves as an instrument of exchange. The wealth of a person exists in its access to the goods and services he desires. The nation as a whole cannot increase its wealth by increasing its stock of money. The principle that only purchasing power means wealth says that Robinson Crusoe would not be a penny richer if he found a gold mine on his island or a case full of bank notes.

8. Labor does not create value

Labor, in combination with the other factors of production, creates products, but the value of the product depends on its utility. Utility depends on subjective individual valuation. Employment for sake of employment makes no economic sense. What counts is value creation. In order to be useful, a product must create benefits for the consumer. The value of a good exists independent from the effort of producing it. Professional marathon runners do not earn more prize money than sprinters because running the marathon takes more time and effort than a sprint.

9. Profit is the entrepreneurial bonus

In competitive capitalism, economic profit is the extra bonus that those businesses earn that fix allocative errors. In an evenly rotating economy with no change, there would be neither profit nor loss and all companies would earn the same rate of interest. In a growing economy, however, change takes place and anticipating changes is the source of economic profits. Business that does well in forecasting future demand earn high rates of profit and will grow, while those entrepreneurs who fail to anticipate the wants of the consumers will shrink and finally must shut down.

10. All genuine laws of economics are logical laws

Economic laws are synthetic a priori reasoning. One cannot falsify such laws empirically because they are true in themselves. As such, the fundamental economic laws do not require empirical verification. Reference to empirical facts serve merely as illustrative examples, they are not statements of principles. One can ignore and violate the fundamental laws of economics but one cannot change them. Those societies fare best where people and government recognize and respect these fundamental economic laws and use them to their advantage.

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An underappreciated idea in economics is what I call the capital/labor ratio. This ratio is not really some kind of numerical statistic, but rather, a way of thinking about problems and solutions. It can be used to illustrate some of the difficulties of free trade, and also, what we should do about them.

From the beginnings of industrialization, around 1780, people wondered if machines would replace human labor, and thus lead to mass unemployment and disenfranchisement. If one person with a steam-powered spinning machine could replace 100 people using old-fashioned spinning wheels, what would happen to those 100 people?

If there was only one spinning machine, then 99 people might be destitute, or be reduced to low-value menial work, like sweeping the factory floor or raking the factory-owner’s yard. They are underemployed. The economy would actually grow. It would have not only the output of the spinning machine, equivalent to the previous output of all 100 people, but it would also have the output of whatever those 99 people ended up doing. Although the one person operating the spinning machine would be very productive, their wages would not be very high, because they could be replaced at any time with one of the 99 low-paid underemployed people. The average productivity of all 100 people would still not be very high.

This is a situation where there is just a little capital – one spinning machine – and a lot of underemployed labor.

However, if there were 100 spinning machines, then all 100 people could be very productive. The output of the economy would be much higher – a hundred times higher than when everyone used old-fashioned spinning wheels. Wages would be high, because you could not get the output of the machines without the employees to run it. Capital would compete for limited labor with higher wages. Any new investment would have to bid away labor from the textiles business, by offering a higher wage; consequently, to be profitable, that labor would have to be used in a manner even more productive than in the textile business. The toilets would still have to be cleaned, and the factory owner would still pay to have the leaves raked from his yard, but he would have to pay a high wage for it.

This is a situation where there is a lot of capital – 100 spinning machines – and no underemployed labor.

“Job destruction” is a normal part of economic expansion, wealth creation, increasing productivity and higher wages. It takes fewer and fewer people for more and more output. But this must be matched by “job creation” – and not just low-paid/low productivity jobs, which consume a lot of labor to create a product or service that can’t be sold for very much, but high-paid jobs which themselves represent the investment of large amounts of capital, to create high productivity.

 Factors such as the end of centrally-planned communism in both China and the former Soviet sphere, or cheap telecommunications which have enabled people from India to make use of their English skills, have radically increased the amount of underemployed labor available in the increasingly globalized world economy. It turns out that a lot of manufacturing is not all that hard. Who would have thought that the miracle of the two-terabyte hard drive could be created by Malaysians, or the iPhone 7 by Chinese? The developed economies, such as Germany, Japan and the United States, have been driven toward manufacturing of capital goods rather than consumer goods, and also, a few industries (like chemical production) where so few employees are needed that labor costs are a minor factor.

Free trade can be a little like the spinning machine. It now takes one person with container ship to create what used to take 100 employees to do.

Our retail stores are filled with a profusion of goods from China, Mexico or Malaysia. We don’t see the complicated capital goods, which are mostly purchased by big corporations. These are things like telecommunications equipment, electric power generation and distribution equipment, the defense industry, the barcode and conveyor-belt systems used in the warehouses of Amazon.com or UPS, equipment for the medical industry like MRI scanners or laboratory test equipment, hardware for the oil and gas or mining industry, the huge industrial plants that make yogurt and beer, or the commercial software that helps it all to function. These kinds of high-value products are the likely future of American manufacturing.

What American labor – the middle class, and the below-middle class – needs today, most of all, is capital investment. This is best accomplished by making the U.S. a great place to do business. It should include tax reform, such as the 15% corporate tax rate that president-elect Donald Trump has proposed. Eventually, this should be extended to everyone, a flat income tax with a rate also around 15%. It also means a rollback of regulatory burdens, which is especially choking off the smaller companies that have always accounted for most job creation. Ideally, it also means a stable dollar – in U.S. history, this means a dollar linked to gold – which does not confuse the capitalist system of prices and returns on capital with monetary distortion, manipulated interest rates, and wild exchange-rate swings. We need real investment in the real, nonfinancial economy, not weird asset bubbles, financial chicanery, and all the other elements of “malinvestment” that arise from unstable money.

This will create a situation where there is a lot of capital investment, relative to available underemployed labor – a situation similar to the 1950s and 1960s.

Where will that capital investment go? It will go, of course, to wherever the return on capital is the highest. This might mean the kind of high-value manufacturing I’ve described. But, we might find that we have enough stuff. People would rather spend their next dollar on something interesting to do. Much of the new investment might be in a variety of services. These would be high-value services. These could be in healthcare and education, for example. But, they could also be in things like restaurants and hospitality. A high-end hotel resort, or a high-end restaurant, takes just as much labor as the low-end versions. The difference is capital – a Four Seasons costs a lot more to build than a Motel 6. Instead of a spinning machine that radically increases the production of cotton cloth, our increasing productivity might express itself as a profusion of high-end restaurant and travel options – if that is what provided the highest return on capital.

Related to all of this is the raw increase of capital itself. The earliest economic writers understood that it was the steady increase of capital invested that made societies wealthier. They always focused on capital accumulation. More spinning machines. This capital investment is the flip side of savings–more savings means more investment. Decades of Keynesian promotion of “consumption” has led to a diminution of savings, and thus, domestic capital creation. This capital deficiency is remedied somewhat by imported capital – a “current account deficit” – but that is problematic on many levels. For one thing, a lot of small business creation arises from personal capital (personal savings), and also friends and family. The local accountant, chiropractor, marriage counselor, construction contractor or rental-apartment investor might never become listed on the NYSE, but these kinds of high-value service businesses, multiplied by the hundreds of thousands, can form the foundation of middle-class prosperity. They are largely locked out other sources of capital, including their local banks, until they reach sufficient size and stability. None of this happens if everyone, and their friends and family, are deep in credit card, automobile and student loan debt; or if oppressive regulatory burdens make it impossible for small businesses to form.

Much more capital investment requires much more capital to invest. This will have to be the foundation of any economic revival in the U.S., whatever trade or tariff policy may be. Without it, nothing much will be accomplished.

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Employment security is a concept that generates legal and economic controversy. This is due to the conflict between the rights of capital to run a business to its maximum profitability and the argument that employees have a right to employment security.

For people living and working in an advanced economy, viz. an economy where there is specilisation within the process of production in goods or services, then employment security ought to depend on access to a market that demands their goods or services.

The law however adds some further stipulations: that employment security can also be taken to include all factors that affect a person’s employment opportunities. These would include factors such as additional protection for limited periods if they choose to leave paid employment to raise children.

The need for employment security was summarised by Judge Perkins, who, was the Judge in my recent case.

“A heavy onus rests upon an employer before a dismissal can be validly effected. The reasons for this are obvious. The right to be in employment and earn the means to support oneself and one’s dependants is a substantial right requiring protection. There is a strong societal imperative behind this, supported by economic need for full employment as founding a strong overall economy. A position of employment is a valuable asset. Employees are the most valuable asset of any business hoping to thrive. If the employment is to be terminated it is essential that it be justifiably fair.”

Clearly the Judge is not an economist.

Employment in production, when analysed as an economic proposition, can be analysed as a series of property rights, which, lends itself to a concurrent legal analysis.

The first right enumerated is ‘the right to be in employment’. This is another way of saying that as an entrepreneur, who supplies the capital, must provide employment.

Clearly this is incorrect. I have a legal right to my property, in this case capital. There is no requirement that I subjugate that right to another who has no legal claim to my property. There can be no ‘right to employment.’

Employees are a valuable asset, but they are no more valuable than other economic inputs, such as raw materials etc. The most valuable asset is capital, without which, there is no business and no employment. Capital pays the wages of the employee.

This is clearly true, as, production takes place over time. Employees are paid before the production results in consumer goods and the capitalist can earn the market return on those consumer goods.

What the law is actually talking about is the right of the employer to discard under-performing employees. Employees who earn less than their ‘discounted marginal value product’. These employees can create losses to capital and quite rationally, the employer wants to discard this underperforming factor of production.

The law does allow this, but requires that the employer evidence this and thereby justify their dismissal. This prevents the employer dismissing employees, not because they are underperforming, but because there is a personality clash and the employer wants to dismiss on this basis.

 

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From Ray Dalio

Now that we’re a month past the election and most of the cabinet posts have been filled, it is increasingly obvious that we are about to experience a profound, president-led ideological shift that will have a big impact on both the US and the world. This will not just be a shift in government policy, but also a shift in how government policy is pursued. Trump is a deal maker who negotiates hard, and doesn’t mind getting banged around or banging others around. Similarly, the people he chose are bold and hell-bent on playing hardball to make big changes happen in economics and in foreign policy (as well as other areas such as education, environmental policies, etc.). They also have different temperaments and different views that will have to be resolved.

Regarding economics, if you haven’t read Ayn Rand lately, I suggest that you do as her books pretty well capture the mindset. This new administration hates weak, unproductive, socialist people and policies, and it admires strong, can-do, profit makers. It wants to, and probably will, shift the environment from one that makes profit makers villains with limited power to one that makes them heroes with significant power. The shift from the past administration to this administration will probably be even more significant than the 1979-82 shift from the socialists to the capitalists in the UK, US, and Germany when Margaret Thatcher, Ronald Reagan, and Helmut Kohl came to power. To understand that ideological shift you also might read Thatcher’s “The Downing Street Years.” Or, you might reflect on China’s political/economic shift as marked by moving from “protecting the iron rice bowl” to believing that “it’s glorious to be rich.”

This particular shift by the Trump administration could have a much bigger impact on the US economy than one would calculate on the basis of changes in tax and spending policies alone because it could ignite animal spirits and attract productive capital. Regarding igniting animal spirits, if this administration can spark a virtuous cycle in which people can make money, the move out of cash (that pays them virtually nothing) to risk-on investments could be huge. Regarding attracting capital, Trump’s policies can also have a big impact because businessmen and investors move very quickly away from inhospitable environments to hospitable environments. Remember how quickly money left and came back to places like Spain and Argentina? A pro-business US with its rule of law, political stability, property rights protections, and (soon to be) favorable corporate taxes offers a uniquely attractive environment for those who make money and/or have money. These policies will also have shocking negative impacts on certain sectors.

Regarding foreign policy, we should expect the Trump administration to be comparably aggressive. Notably, even before assuming the presidency, Trump is questioning the one-China policy which is a shocking move. Policies pertaining to Iran, Mexico, and most other countries will probably also be aggressive.

The question is whether this administration will be a) aggressive and thoughtful or b) aggressive and reckless. The interactions between Trump, his heavy-weight advisors, and them with each other will likely determine the answer to this question. For example, on the foreign policy front, what Trump, Flynn, Tillerson, and Mattis (and others) are individually and collectively like will probably determine how much the new administration’s policies will be a) aggressive and thoughtful versus b) aggressive and reckless. We are pretty sure that it won’t take long to find out.

In the next section we look at some of the new appointees via some statistics to characterize what they’re like. Most notably, many of the people entering the new administration have held serious responsibilities that required pragmatism and sound judgment, with a notable skew toward businessmen.

Perspective on the Ideology and Experience of the New Trump Administration

We can get a rough sense of the experience of the new Trump administration by adding up the years major appointees have spent in relevant leadership positions. The table below compares the executive/government experience of the Trump administration’s top eight officials* to previous administrations, counting elected positions, government roles with major administrative responsibilities, or time as C-suite corporate executives or equivalent at mid-size or large companies. Trump’s administration stands out for having by far the most business experience and a bit lower than average government experience (lower compared to recent presidents, and in line with Carter and Reagan). But the cumulative years of executive/government experience of his appointees are second-highest. Obviously, this is a very simple, imprecise measure, and there will be gray zones in exactly how you classify people, but it is indicative.

Below we show some rough quantitative measures of the ideological shift to the right we’re likely to see under Trump and the Republican Congress. First, we look at the economic ideology of the incoming US Congress. Trump’s views may differ in some important ways from the Congressional Republicans, but he’ll need Congressional support for many of his policies and he’s picking many of his nominees from the heart of the Republican Party. As the chart below shows, the Republican members of Congress have shifted significantly to the right on economic issues since Reagan; Democratic congressmen have shifted a bit to the left. The measure below is one-dimensional and not precise, but it captures the flavor of the shift. The measure was commissioned by a National Science Foundation grant and is meant to capture economic views with a focus on government intervention on the economy. They looked at each congressman’s voting record, compared it to a measure of what an archetypical liberal or conservative congressman would have done, and rated each member of Congress on a scale of -1 to 1 (with -1 corresponding to an archetypical liberal and +1 corresponding to an archetypical conservative).

When we look more specifically at the ideology of Trump’s cabinet nominees, we see the same shift to the right on economic issues. Below we compare the ideology of Trump’s cabinet nominees to those of prior administrations using the same methodology as described above for the cabinet members who have been in the legislature. By this measure, Trump’s administration is the most conservative in recent American history, but only slightly more conservative than the average Republican congressman. Keep in mind that we are only including members of the new administration who have voting records (which is a very small group of people so far).

While the Trump administration appears very right-leaning by the measures above, it’s worth keeping in mind that Trump’s stated ideology differs from traditional Republicans in a number of ways, most notably on issues related to free trade and protectionism. In addition, a number of key members of his team—such as Steven Mnuchin, Rex Tillerson, and Wilbur Ross—don’t have voting records and may not subscribe to the same brand of conservatism as many Republican congressmen. There’s a degree of difference in ideology and a level of uncertainty that these measures don’t convey.

Comparing the Trump and Reagan Administrations

The above was a very rough quantitative look at Trump’s administration. To draw out some more nuances, below we zoom in on Trump’s particular appointees and compare them to those of the Reagan administration. Trump is still filling in his appointments, so the picture is still emerging and our observations are based on his key appointments so far.

Looking closer, a few observations are worth noting. First, the overall quality of government experience in the Trump administration looks to be a bit less than Reagan’s, while the Trump team’s strong business experience stands out (in particular, the amount of business experience among top cabinet nominees). Even though Reagan’s administration had somewhat fewer years of government experience, the typical quality of that experience was somewhat higher, with more people who had served in senior government positions. Reagan himself had more political experience than Trump does, having served as the governor of California for eight years prior to taking office, and he also had people with significant past government experience in top posts (such as his VP, George HW Bush). By contrast, Trump’s appointees bring lots of high quality business leadership experience from roles that required pragmatism and judgment. Rex Tillerson’s time as head of a global oil company is a good example of high-level international business experience with clear relevance to his role as Secretary of State (to some extent reminiscent of Reagan’s second Secretary of State, George Shultz, who had a mix of past government experience and international business experience as the president of the construction firm Bechtel). Steven Mnuchin and Wilbur Ross have serious business credentials as well, not to mention Trump’s own experience. It’s also of note that Trump has leaned heavily on appointees with military experience to compensate for his lack of foreign policy experience (appointing three generals for Defense, National Security Advisor, and Homeland Security), while Reagan compensated for his weakness in that area with appointees from both military and civilian government backgrounds (Bush had been CIA head and UN ambassador, and Reagan’s first Secretary of State, Alexander Haig, was Supreme Allied Commander of NATO forces during the Cold War). Also, Trump has seemed less willing to make appointments from among his opponents than Reagan was (Reagan’s Chief of Staff had chaired opposing campaigns, and his Vice President had run against him).\

By and large, deal-maker businessmen will be running the government. Their boldness will almost certainly make the next four years incredibly interesting and will keep us all on our toes.

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